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Jeff Saut Presents: Predictions?!


"If Santa fails to call the bears will roam on Broad and Wall."


Editor's Note: The following article was written by Raymond James Chief Investment Strategist, Jeff Saut. It has been reproduced with permission for the benefit of the Minyanville community.

"Making predictions is always difficult, especially about the future." That quote was proffered by Yogi Berra from an era gone by, yet we have used it ever since entering this business in 1971. And just like clockwork, around this time of year, the media contacts us inquiring about prognostications for the upcoming year. Historically, our response to such questions has been to answer with a line from Benjamin Graham's legendary book "The Intelligent Investor." To wit:

"An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."

Note that Graham tells us that what is required is an ADEQUATE return, not a SPECTAULAR return. Also notice that, "Operations not meeting these requirements are speculative." Therefore, while forecasting may be fun and exciting, it is by default s-p-e-c-u-l-a-t-i-o-n. Nevertheless, our computer "lights up" this time of year with questionnaires requesting prognostications for 2007. Here is one such example:

1) What is your target for the S&P 500 a year from now?

Answer: Assume the S&P 500 is going nowhere and invest accordingly. Our investment approach has typically centered on trying to invest in "cheap" stocks, since good things tend to happen to "cheap" stocks. That strategy has allowed our Analysts Best Picks to achieve a 38.3% per annum return over the past 10 years.

2) How much do you expect S&P earnings to grow in 2007?

Answer: Less than the consensus projections.

3) When the Fed moves again, which direction will it be?

Answer: The "fooler," in 2007, may just be that the economy re-accelerates and the Fed actually raises interest rates, not lowers them.

4) When will the Fed make its move?

Answer: Who knows?

5) Interest Rates. The Fed funds rate is currently 5.25%. Where will it be a year from now?

Answer: Unchanged.

6) The 10 year T'note is trading just above 4.5%. Where will it be a year from now?

Answer: You might as well "flip" a lucky penny.

7) What is your expectation for economic growth next year?

Answer: The current economic environment is rendering "mixed" signals. While the headline figures suggest slower economic growth, many of the numbers we look at are actually accelerating. Consequently, we are confused and accordingly cautious.

8) What do you expect to see as the high, low, and average prices for oil in 2007?

Answer: We have been energy "bulls" for the past five years and remain so. With 5 billion new entrants joining the world's economy the demand for energy can only increase. Therefore, we continue to think the era of cheap oil is over. As for how high oil prices go, hereto you might as well "flip" a lucky penny.

9) What will the best performing stock sector be next year?

Answer: Large-cap growth is cheaper than large-cap value for the first time in more than 30 years. This is why we have tilted portfolios toward large-cap growth since the beginning of 2006.

10) Best stocks for 2007?

Answer: Cheap stocks, preferably with dividends.

11) Worst stocks?

Answer: Stocks that go down in price, which is why we continue to embrace our mantra since the Dow Theory "sell signal" of September 1999 – Don't let ANYTHING go more than 15 – 20% against you!

12) Will the boom in private equity deals continue?

Answer: As long as there is excess money in private equity funds chasing returns, the M&A activity will continue driven by the Jessica Simpson investment style, "I totally don't know what it is, but I want it!"

13) Will hedge funds outperform or underperform or match the returns of the S&P 500?

Answer: There are currently more hedge funds than there are stocks. By definition then, most hedge funds will probably underperform over the long-term.

Another one of our emails read, "What are we doing now that might implode, as did the tech boom of the late 90s and the real estate boom of the late '80s? Like everybody, our biggest fear in advising clients is not for the short term, or the to-be-expected pullbacks, but the big mistakes that we make. What might rise up to bite us in 2007?" Well, as stated in the aforementioned survey, "The 'fooler,' in 2007, may be that the economy re-accelerates and the Fed actually raises interest rates." And, that potential scenario was reinforced by our sojourn to Washington, D.C. last week to see old friends on Capitol Hill.

Having lived around "The Beltway," we have a pretty decent sense for how the political winds blow. Last week's visit to "The Hill," however, surprised us. Indeed, we arrived thinking that political gridlock was likely to be the course over the next few years, but that sense changed after a few conversations. Surprisingly, we found many of our Republican and Democratic leaders pretty much in agreement on numerous things. Of particular note was a near unanimous agreement between the Congressional folks from states devastated by companies moving jobs offshore. While said Congressmen can't force companies to keep jobs in their states, one thing they can do is vote for an increase in the defense budget and mandate that those attendant high-paying jobs be kept in the United States. The last time such a defense build-up occurred was during the Reagan years and it led to a BOOM in economic activity punctuated by near 8% GDP growth. And maybe, just maybe, that is what the stock market is "seeing." The quid pro quo is that such a boom would obviously be accompanied by more rate ratchets from the Fed . . . aka, "the fooler."

Whatever the outcome, we have been bullish on the defense sector since 4Q99, and bullish on the homeland security space since 4Q01. While we have recommended most of the major defense stocks over the last seven years, the easiest way for investors to play this theme is via the Exchange Traded Funds (ETFs). Consistent with that, we suggest considering the iShares Aerospace & Defense Index (ITA/52.97) and the PowerShares Aerospace & Defense Portfolio (PPA/18.47). As for homeland security, our fundamental analyst's favorite idea currently is L-1 Identity Solutions (ID/$15.30/Strong Buy). L-1 Identity Solutions, Inc., formerly Viisage Technology, Inc., is engaged in developing technologies to solve identity related problems. Its customers include government entities, law enforcement and border management agencies, and commercial enterprises.

The call for this week: Just about every major index we monitor was lower in price last week except for the grains (corn, wheat, soybeans, etc.). Particularly troubling was the D-J Transportation Average's (DJTA) break below its 200-day moving average (DMA), leaving the Transports bearishly configured. Combining the Transport's breakdown with economically-sensitive copper's similar slide caused one Wall Street wag to lament, "Can you spell recession?!" While we are still not in the recession camp, we do think the odds of a recession have risen, especially when one studies the nearby housing chart from the good folks at As for this week, "If Santa fails to call the bears will roam on Broad and Wall."

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